The smartest reaction so far to the Kinsley-Krugman hyperinflation debate comes from Ryan Avent:
The pain of hyperinflation is every bit as bad as and worse than the pain of tax increases, or spending cuts, or default. No politician would risk it, and even if the politicians were willing to, America’s independent Fed wouldn’t let them.
The truth about hyperinflation is that it isn’t so much an economic phenomenon as a political one; it corresponds to the complete breakdown of a country’s political institutions…
To get from America’s current situation to one in which hyperinflation is a realistic possibility, one must pass through an intervening step in which America’s political institutions utterly collapse. And I submit that if Mr Kinsley has reason to believe that such a collapse is imminent, he should be writing columns warning about that rather than the economic messes which might follow.
It’s also worth expanding on what Ryan’s hinting at in his reference to “America’s independent Fed” — and that’s a neat little rhetorical sleight-of-hand on the part of Kinsley. Consider:
The Federal Reserve is independent, but Congress and the White House have ways to pressure the Fed. Actually, just spending all this money we don't have is one good way.
Compared with raising taxes or cutting spending, just letting inflation do the dirty work sounds easy. It will be a terrible temptation, and Obama's historic reputation (not to mention the welfare of the nation) will depend on whether he succumbs. Or so I fear.
Kinsley continues:
Hyperinflation is the result of explicit policy choices by public officials… There are reasons to worry that our political leaders may opt for inflation even if there is no economic evidence of it happening naturally.
The logic here is that simply running large fiscal deficits is an “explicit policy choice” by officials who “opt for inflation”. Just by spending money, the government is pressuring the Fed to, um, what, exactly? Keep interest rates too low? Print money?
It’s true that the Fed isn’t looking particularly independent these days, but that’s largely because inflation isn’t a problem, and therefore the Fed is rightly concentrating on the second part of its dual mandate, which is reducing unemployment through loose monetary policy. Fiscal policy and monetary policy should both be pulling in the same direction right now — which is the direction of trying to extricate the country from the deepest recession in living memory.
It’s also hard to see the dynamics by which hyperinflation — or even plain old ordinary high inflation, for that matter — could emerge. If there’s a panicked run away from the dollar and dollar-denominated assets, that would hurt both the stock market and the bond market, hitting wealth hard. It would also send the cost of imports up. But the US doesn’t import so much that import-price inflation would pass through into domestic hyperinflation. And with the markets in turmoil, weak unions, and unemployment surely rising, I don’t think that workers would be in any position to ask for double-digit wage increases on an annual basis. In any case, to have any hyperinflation you need a maniac helming the printing press, and Ben Bernanke is not a maniac. Yes, he’s expanded the money supply significantly, but only when disinflation was the greatest risk facing the economy. It’s almost impossible to imagine the Fed continuing to print money once consumer prices start rising sharply on Main Street — and, frankly, it’s hard to imagine the Obama administration putting pressure on the Fed to do so.
As Krugman notes, it’s instructive to take a hard look at Japan, which ran enormous deficits for many years and which still has no sign of any inflation any time soon. Deficits, in and of themselves, do not cause inflation. And while Kinsley is right that there’s no obvious way out of America’s current fiscal problems, he’s wrong that politicians can simply choose inflation as an option. Just as the Treasury secretary does not control the value of the dollar, the president does not control the trajectory of consumer prices. So in order for his fears about hyperinflation to be remotely justified, Kinsley first has to explain how the Fed is going to transmogrify into the Reserve Bank of Zimbabwe. And he hasn’t come close to doing that.
The only way we will see inflation is if China decides to devalue the dollar relative to the renminbi. Fortunately for most people outside of China, they’re not going to do that. Politicians should stop whining about China’s undervalued currency, and send thank-you notes to the workers there who are willing to work so hard to support the middle class in America.
Federal budget deficits as large as the ones we are now running would normally create inflationary pressure, but given that overall consumption is down and that most other industrialized nations (the ones whose currency matters, anyway) are also running deficits, there are no economic forces that would drive up inflation (beyond a major disaster or artificial price increase in a core cost component, like energy or food). If every nation is printing money, then no one currency will lose value relative to another.
Japan didn’t have inflation because they were also running huge trade surpluses. They could finance their public debt from profits on exports.
And about the Fed not looking independent these days – they weren’t very independent when bush was president, as they gladly carried out his “lend money cheaply to anybody who is breathing” policy, which was the basis for the imaginary growth during six years of his regime.
A big drop in the dollar would cause the stock market to drop in foreign currency terms, but likely not in dollar terms. At least to my recollection the Argentine stock market went up in peso terms when they devalued by a factor of 3, though you might have better resources to check on that than I currently do. That this is what jibes with what I would intuitively expect may be reason to mistrust it, though.
There is alot of regular inflation between here and hyperinflation.
We can see inflation if financial institution balance sheets begin expanding and the Fed fails to shrink the amount of excess reserves that it holds by selling securities that it holds.
The current problems in the economy have been debated endlessly (or so it seems) almost everywhere.
Rarely, however, do I see it asserted that SOME inflation would be of significant benefit. I believe there are a number of reasons this would be the case. But first, we must define what we mean by “inflation.” In this case, it is not actually INFLATION but a REFLATION, in particular of real estate. The purpose of such a reflation would be to reduce the amount of bad loans on the books of financial institutions by reducing the number of real estate mortgagees who are upside down.
Even in mainstream Monetary Economics, it is asserted that SOME inflation is beneficial, acting as it does, as the “grease” of the economic wheels.
Those who are overly afraid of inflation have valid points, as well, notably that it is difficult to put the genie back into the bottle. However, they seem to forget that Deflation too is a genie, and a particularly evil one, at that.
Looking at Japan, the government has been borrowing to stimulate via spending unsuccessfully for the better part now of 20 years. So too, did the United States stimulate via deficit spending in the 1930s, generally unsuccessfully (much debate possible here, of course).
So, ladies and gentlemen, let us welcome some inflation if not as a cure to our ills, at least as a cure to some ills (deflation).
JH
Kinsley is a smart guy, but he’s not an economist, and his use of the term “hyperinflation” incorrect — 13% inflation is not hyperinflation in any professional lexicon. Ryan’s comments, while correct, are addressing Weimar, not Kinsley. Institutions don’t have to collapse to have 13% inflation; all you need is Jimmy Carter and some Arabs plugging a well. Hyperinflation is not a possibility in the US. Another round of Jimmy Carter is.
What the President and Congress can do, and which they pretty much have been doing, is to build a doomsday machine in which the amount of debt built into the system is greater than an amount that can be paid back in present money.
Then the Fed is forced into a choice. The debt can be inflated away or there can be mass defaults and deflation. It is not rocket science to guess that the Fed will choose door number one, since that is what the Fed has done for the last 75 years, and the world has not ended.
Felix, you are right that genuine hyperinflation is unlikely. After a few years at, say, 10% inflation, even the most enormous debt overhang begins to resolve itself.
One difference between the United States and other countries that issue their own currency is that with most other countries, there is a hard currency alternative to the local currency.
If a nation’s residents stop believing in their own currency, and there is a hard alternative (for Zimbabwe, the US Dollar), the real private-sector economy can suddenly shift to hard currency, making a hyperinflation almost inevitable. The psychological shift can happen very fast. The government is left with a currency abandoned by the most of the productive part of the economy. There is no way to raise enough revenue to maintain the government from the private sector, which has effectively gone underground by shifting to a hard currency. The government must then print and maybe buy a little time and or cease functioning right now.
Did Weimar Germany have hyperinflation as its goal? Of course not. But once the population lost faith in the Mark and found an alternative, hyperinflation was inevitable.
Is there any hard alternative to the dollar that would make such a switch possible? Many say no. How far off are the Yuan, gold, etc.?
Actually, the history of Weimar Germany does not bode well for us. Why?
They mainly didn’t jump to a hard currency. Instead, they sought all manner of tangible goods and moved largely toward barter. As faith was lost in the currency, economic activity moved away from the reach of government. As unemployment increased, revenue collapsed as well.
The government, faced with an utter collapse in revenue and no external source of funding, had printing as its only viable revenue source. Apparently during the process, 99% of revenue came from printing and 1% came from taxes.
The printing wasn’t even the half of it. Much of the inflation came from increases in velocity of money, led money multipliers orders of magnitude higher than normal. Folks who did not trust the money were very eager to spend it.
While this circumstance may seem unlikely, I can’t think of a hard proof that it cannot happen here. If external funding simply dried up, the United States would have to cut spending by what, 40%?
This alone would cause a depression.
The commenters who argue that Weimar Germany did not choose inflation or explain Weimar Germany’s hyerinflation from the development of a barter economy seem to be missing some history. Even the comment that it would take a maniac to pursue hyperinflation is not quite right– the President of the Reichsbank circa 1922 was considered an enlightened, conservative fellow.
The Weimar hyperinflation was a direct response to Germany’s political decision to default on reparations. It was a rational calculation to show the Allies that Germany could not afford to pay. It’s most rapid phase coincided with the German government’s policy of noncompliance and strike against the French occupation of the Rhineland. Ryan Avent’s original comment was most correct: hyperinflation is a political, more than economic, event.
John Mauldin had an interesting bit on the velocity of money a couple of weeks back.
http://www.investorsinsight.com/blogs/th oughts_from_the_frontline/archive/2010/0 3/13/the-implications-of-velocity.aspx
The point is, velocity of money is its own separate money multiplier, completely apart from printing. Recently, printing has been substantial while velocity has collapsed, balancing things out.
Suppose there is a moderate loss of confidence in the dollar and velocity doubles. It has, after all, seen doublings and halvings during the last century. That would mean 100% inflation. Where does that fall on our scale?
In hyperinflations velocity has typically increased 1000%. That would mean inflation of 1000%.
Remember, this is not printing but a loss of confidence in the money.
If that weren’t enough, movement of some portion of the economy to alternatives (other currencies, Gold, barter) would free up dollars and would act like printing.
Gee, now I don’t feel safe from inflation at all! It should be noted that deflation has commonly preceded inflation.
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